We shall discuss the debate about whether to use the Futures chart or the spot price chart when trading in the FNO (Futures and Options) market, how future prices are derived and introduce a Cash and Carry Arbitrage strategy.
a) Spot Price: The spot price refers to the current market price of a particular asset or stock at a given moment.
b) Futures Price: The futures price is a derivative of the spot price. It is the price at which a futures contract for an asset is traded. Futures prices can differ from spot prices due to various factors.
Why Use It?
-> Traders use the Futures chart for FNO trading because futures contracts have fixed expiry dates, providing clarity on market movements leading up to expiration.
-> Futures charts offer a more accurate representation of supply and demand dynamics, as they are based on future prices, aligning with FNO trading principles.
Analysis-> Instrument Overview-> Futures-> Future Vs Spot
How to Use It
-> A trading strategy discussed in the video is Cash and Carry Arbitrage, which capitalizes on price differences between spot and futures prices.
-> To implement this strategy, traders buy the underlying asset (spot) and simultaneously sell its equivalent futures contract when there is a significant price difference.
-> The goal is to profit from the convergence of spot and futures prices at the time of contract expiration.
a) Why do spot and futures prices differ?
-> Spot and futures prices can vary due to factors like the risk-free rate, time to contract expiry, and potential dividends. These differences are collectively referred to as the “basis” or “spread.”
b) How is the Futures price calculated?
-> The Futures price is calculated using the formula: Futures Price = Spot Price × (1 + Risk-Free Rate × (Time to Expiry / 365)) – Dividends. The risk-free rate is often approximated using the RBI 91-day treasury bill rate.
c) When should I use the Futures chart or spot chart for trading?
-> Traders often use the Futures chart for FNO trading due to fixed expiry dates and a more accurate representation of supply and demand. For regular equity trading, the spot chart is suitable for immediate buy and sell decisions. However, the movement of spot and futures prices should align, and they must converge at contract expiry.
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